Editor’s Note: This article was originally published in the March 2012 edition of
, a monthly Italian publication on world affairs.
As the IMF celebrates its 65th birthday, the world economy still battles its way out of the worst crisis in almost a century. Five years from the start of financial upheaval, Europe, the largest economic block and issuer of the world’s second most traded currency, finds itself in the midst of an unprecedented crisis that could well trigger a meltdown of the global financial system. On the other side of the Atlantic, the United States has yet to provide full confidence that its fiscal policies will be sustainable over the medium term so as to avert a dollar crisis in the near future. Meanwhile, a sudden slowdown in some of the larger emerging economies, prompted by the interaction of domestic and external vulnerabilities, could further escalate the risk of implosion for the world economy – which might take decades to recover from.
Against this backdrop, the IMF has managed, once again, to reassert itself. In 2009, at the height of the international financial crisis, the IMF became the key international organization supporting G-20 leader summits, by offering critical analysis and advice to steer official attempts to contain the devastating potential of the crisis. Moreover, for the first time in the organization’s history, the managing director has interacted with presidents and prime ministers from systemically important economies of the G-20 on a regular basis. And, in Europe, she now attends meetings of finance ministers and summits held by European Union leaders.
Historically, the IMF has often been on the frontline of international policymaking. In the first two decades of its existence, it served as the upholder of the Bretton Woods fixed exchange rate system. In the 1980s, it was heavily involved in the debt crisis of developing countries, especially in Latin America. In the 1990s, it engaged in the structural transformation of the former communist economies in Eastern Europe and Central Asia. More recently, in the last decade, it boosted its role in low-income countries, mostly in Africa. Now, it is confronting its most daunting task yet: to stabilize a systemic region, the EU, whose size dwarfs the institution’s meager resources. More broadly speaking, this mirrors the challenge of becoming a systemic player in a world dominated by huge-scale private capital flows and an increasingly globalized economy.
Upon closer scrutiny, and beyond its frontline stance in international policymaking, one wonders whether the IMF and its membership have truly reached the high bar set by the Fund’s founding fathers. The evidence is quite mixed and highlights an ambitious agenda yet to pursue. In the vision of international monetary cooperation held by one of the most important participants at the Bretton Woods Conference in 1944, Lord Maynard Keynes, a fundamental premise was that creditor as well as debtor nations should assume responsibility for current account adjustments. Otherwise, the absence of any corrective, symmetrical mechanism, he pointed out, would generate a global deflationary bias. Under the current system, it is usually not feasible for external surpluses and deficits to compensate for each other without negatively affecting global economic activity. When confronted with insufficient financing, deficit countries must make an adjustment to balance their external accounts; these efforts will not, however, be equaled by expansionary policies in surplus countries, which are under no pressure to adjust. In fact, a reduction in the United Kingdom’s current account deficit would not necessarily have been compensated by a corresponding expansion in the aggregate demand set by the US, then in surplus.
This realization influenced on some level the founding discussions of the IMF, leading to the significant, if ambiguous, wording of Article I of the IMF’s Articles of Agreement, which states that the purpose of the Fund is “to promote international monetary cooperation through a permanent institution which provides the machinery for consultation and collaboration on international monetary problems.” And, in fact, the IMF became the overseer of efforts by member countries to liberalize their current account transactions and to uphold the Bretton Woods rule-based system of exchange rates. This was meant to encourage international trade and growth by making sure that every currency was convertible for the purpose of current account transactions and by ensuring that the exchange rate system was stable. The global deflationary bias was, in a way, being softened by laying the long-run foundations for an open global economy and by endowing the IMF with the powers to regulate it. In this context, the IMF would provide temporary balance-of-payment financing to ease adjustment, yet without affecting the basic asymmetry of the system, as the adjustment burden would still ultimately lie with the deficit country.
In the early 1970s, the Bretton Woods fixed parities system was abandoned. Soon after, in 1976, the Interim Committee of the IMF met in Jamaica to start the process of amending the institution’s Articles of Agreement. The outcome was the Second Amendment of 1978, which established the framework for the Fund’s modern surveillance function. What the new framework did, in essence, was respond to the desire of member countries, the US first and foremost, to create a flexible regime that would promote adjustment by way of regular consultations, while leaving to the discretion of individual countries the specific conditions for reaching domestic macroeconomic objectives.
This new regime strayed substantially from that of the original Bretton Woods, whereby it was the anchor of the pegged exchange rate – overseen by the IMF – that determined necessary internal adjustment. Without any clear international rules, the new system gave greater importance to consultations and to responsibility at the country level. At its core, the revised Article IV shifted authority back to member countries and away from the IMF. The IMF did remain responsible for helping members avoid a unilateral setting of exchange rate policies by individual nations, though it had few instruments, if any, to help it do so. A further blow to IMF efforts toward a genuine multilateral consultation system was the 1982 initiative of some key member countries – France, Germany, Japan, the UK, and the US – to establish a multilateral surveillance forum of their own to monitor their monetary and exchange rate policies. Although the exercise would purportedly be in conjunction with the IMF, early on it became clear that the G-5 (later the G-7, with the inclusion of Italy and Canada) would in fact be in charge.
Most recently, with the establishment of the G-20 as the premier forum for international economic consultations, its leaders pledged to mutually assess their economic policies on the basis of the so-called “Framework for Strong, Sustainable, and Balanced Growth,” proposed by the US in Pittsburgh in September 2009. Through this framework, leaders pledged to devise a method for setting objectives, to develop policies to support such objectives, and to assess outcomes through mutual evaluation. The IMF’s involvement was sought in providing analysis on various national and regional policy frameworks and how they fit together; ultimate ownership of the exercise, however, rested entirely with the G-20. Though G-20 countries have all committed to a peer-review process for their economic policies and to a broadly-defined policy objective, they have not committed to numerical policy targets – in line with quantitative objectives set for the overall group – for which a multilateral forum could hold them accountable. This situation is not unlike that of the Fund in the 1970s, when systemically important economies were urged to commit to a multilateral surveillance framework. Ultimately, the countries distanced themselves from specific commitments, and the notion of multilateral surveillance became little more than an IMF forum for exchanging views and information on the economic policies of member countries. To truly enable the IMF to fulfill its multilateral surveillance role, the membership should have endowed the institution with significant political capital and instruments of enforcement, something it never did.
As for governance, the G-20 appears to have facilitated a set of long-overdue institutional reforms. In November 2010, leaders at the G-20 summit in Seoul endorsed a package of IMF governance reforms that surpassed expectation, shifting about 6% of voting power to dynamic and underrepresented economies. Under the new arrangement, approved by the IMF itself and expected to be ratified by the membership this year, China assumes the rank of third shareholder in the IMF, with Brazil and India, thanks to their revised quotas, coming in among the top ten. Moreover, the quota review will be linked to a re-composition of the board itself, with Western Europeans giving up two seats at any given time. While the seat chaired by Italy is not expected to be immediately affected, the recomposition, nonetheless, signals the urgency to formulate a more proactive strategy vis-à-vis the Fund and its membership, in order to ensure that the country’s vision and interests are adequately represented in the future.
The role of the IMF in the G-20-led process highlights a further governance challenge. As in the case of the G-7, the Fund continues to enjoy an advisory function. However, its advisory role is more clearly spelled out and is also far more strategic, given the greater number of countries in the G-20. Even so, how the advisory role relates to the Fund’s fulfillment of its mandated critical tasks is not at all evident, as witnessed, for example, by the US proposal to grant authority to the G-20 – not the IMF – on the issue of China’s exchange rate. The executive board of the IMF, moreover, does not play a part in formulating Fund advice to the G-20. Many members of the G-20 do sit on the board of the IMF, thereby assuring their involvement via their respective capitals; however, most of the executive directors represent a group of countries, and not just those that nominated them.
Were the G-20 to become a formal decision-making ministerial body within the IMF itself, the dualism between the two would no longer be an issue. Furthermore, such an arrangement boasts two distinct advantages: not only would it increase the legitimacy of theG-20, since each member of the ministerial committee would also represent a number of other countries based on the constituency system that underpins IMF governance, but the new arrangements would also bolster the IMF’s fundamental role as overseer of the international monetary system, thus granting the institution political impetus as yet unseen.
While these may be reforms for the medium term, the European battlefield is exposing a critical gap for the IMF’s effectiveness in the current global financial system: the ability, in a potentially systemic crisis, to discharge a key coordinating role within the membership and to deploy a credible firewall, under adequate safeguards, to counter contagion and Knightian uncertainty that sovereigns on their own cannot withstand. In the event of a systemic event, the IMF should proactively provide precautionary financial aid to countries (or a region) facing large-scale liquidity shortages. The process for activating such a mechanism could fall to the authority of the executive board, thus conveying to markets the full support of the international community in responding to a systemic crisis and in preserving confidence in the global financial system. Initial efforts in this regard have not proven encouraging, however, due to the opposition of those who underscore national discipline over the stabilizing effect of collective action. Yet, upon closer inspection, this opposition rests on a fundamental misunderstanding: a large enough firewall would not in fact amount to free access to IMF resources; quite the contrary, as those resources would be deployed under adequate safeguards, which would no doubt entail conditionality, as is typical of IMF lending programs. If anything, the leverage of the international community to encourage timely and credible policy-stabilizing actions before too much damage is done would increase hand-in-hand with Fund involvement. The IMF’s managing director, Christine Lagarde, has consistently offered German Chancellor Angela Merkel a way out against the prospect of an escalating crisis in Europe, though, so far, to no avail.